“This is what we should do,” Kashkari told Paulson. He had been involved in HOPE NOW, one of the government’s early efforts at helping distressed homeowners, and had learned firsthand how difficult it would be to get the banks making new loans as long as they were carrying bad loans on their balance sheets. On the speakerphone from New York, where he still was embroiled in the AIG situation, Paulson’s adviser Dan Jester argued that the purchasing of assets was too cumbersome and recommended instead that capital be injected directly into the institutions. “The more bang for your buck is to put capital in,” he said, explaining that even if the market continued to fall, it would help the banks manage the downturn.
The difficulty with that approach, countered Assistant Secretary David Nason, was the specter of nationalization. If the government put money into firms, it became a de facto owner, which is precisely what most of the people in the room wanted to avoid. “Are people going to think we’re going to AIG them?” he asked, already using the government’s investment less than twenty-four hours earlier as a verb. Paulson had liked the “Break the Glass” idea when it had first been presented to him and was now leaning to move in that direction. AIG was a disaster they couldn’t afford to repeat, and buying the assets maintained a clear border between government and the private sector. The job now was to begin preparing the outlines of legislation for Congress. They were going to need a ton of money, and they were going to need it immediately.
He assigned Kashkari and a team of staffers the task of fleshing out the idea; “Break the Glass” might have been an interesting document in theory, but it lacked details and was far from executable. He gave them twenty-four hours to fill them in.
Before ending the meeting, Paulson asked, “How much is this going to cost?”
Kashkari, who had originally estimated the expense at $500 billion back in the spring, said gravely, “It’s going to be more. I don’t know, maybe even double.”
Dismissing everyone with a warning that their conversation had been confidential, Paulson then called Geithner to compare notes. “You cannot go out and talk about big numbers with regard to capital needs for banks without inviting a run,” Geithner told him. “If you don’t get the authority, I’m certain you’ll spark a freaking panic. You have to be careful about not going public until you know you’re going to get it.”
By midafternoon Wednesday, Morgan Stanley’s stock had fallen 42 percent. The rumors were flying: The latest gossip had the company as a trading partner with AIG, with more than $200 billion at risk. The gossip was inaccurate, but it didn’t matter; hedge funds continued to seek nearly $50 billion in redemptions. Hoping to poach Morgan Stanley’s hedge fund clients, Deutsche Bank was sending out fliers with the headline: “DB: A Solid Counterparty.”
John Mack was meeting with his brain trust, already anticipating what had become a grim end-of-day ritual. At 2:45 p.m., hedge funds would start pulling money out of their prime brokerage accounts, asking for all the credit and margin balances. At 3:00, the Fed window would close, leaving the firm without access to additional capital until the following morning. Then, at 3:02, the spread on Morgan Stanley’s credit default swaps—the cost of buying insurance against the firm’s defaulting—would soar. Finally, its clearing bank, JP Morgan, would call and ask for more collateral to protect it.
“It’s outrageous what’s going on here,” Mack almost shouted, arguing that a raid on Morgan Stanley’s stock was “immoral if not illegal.” Intellectually he understood the benefit that shorts provide in the market—after all, many were his own clients—but at risk now was his own survival.
Colm Kelleher, Morgan Stanley’s CFO, was more fatalistic—the short-sellers couldn’t be stopped, he believed, or even necessarily blamed. They were market creatures, doing what they had to do to survive. “They are cold-blooded reptiles,” he told Mack. “They eat what’s in front of them.”
Mack had just gotten off the phone with one of his closest friends, Arthur J. Samberg, the founder of Pequot Capital Management, who had called about withdrawing some money.
“Look, if you want to take some money out, take money out,” Mack told him, frustrated.
“John, I really don’t want to do it, but my fund-to-funds accounts are saying I have too much exposure to Morgan Stanley,” he said, citing the rumors about its health.
“Take your money,” Mack told him, “and you can tell all your peers to take their credit balances out.”
Mack believed negative speculation was purposely being spread by his rivals and repeated uncritically on CNBC. He was so furious with the “bullshit coverage” that he called to complain to Jeff Immelt, the CEO of GE, which owned CNBC as part of its NBC Universal unit.
“There’s not a lot we can do about it,” Immelt could only say apologetically.
Tom Nides, Mack’s chief administrative officer, thought they needed to go on the offensive. Nides, a former CEO of Burson-Marsteller, the public relations giant, had been one of Mack’s closest advisers for several years, his influence so great that he had persuaded the lifelong Republican to support Hillary Clinton. He now encouraged Mack to start working the phones in Washington and impress upon them the need to instate a ban against short selling. “We’ve got to shut down these assholes!” he told Mack.
Gary Lynch, Morgan Stanley’s chief legal officer and a former enforcement chief at the SEC, volunteered to call Richard Ketchum, the head of regulation of the New York Stock Exchange, and put a bug in his ear about suspicious trading. “I’m in favor of free markets—and I’m in favor of free streets too, but when you have people walking down the streets with bats, maybe it’s time for a curfew,” he said.
Nides set up a series of phone calls for Mack, who also contacted Chuck Schumer and Hillary Clinton, pleading with them to call the SEC to press the case on his behalf. “This is about jobs, real people,” he told them.
After speaking with Christopher Cox, the head of the SEC, however, he was in an even fouler mood. Cox, a free-market zealot, seemed to Mack to be almost intentionally ineffectual, as if that were the proper role of government regulators. There was nothing he was going to do about the shorts, or about anything at all, for that matter.
Paulson, who was next on his call list, was clearly sympathetic to Mack’s cause to ban the short-sellers, but it was unclear whether he could do anything to help him. “I know it, John. I know it,” he said, trying to pacify him. “But this is for Cox to decide. I’ll see what I can do.”
Mack then contacted his most serious rival, Lloyd Blankfein of Goldman, desperate for an ally. “These guys are taking a run at my stock, they’re driving my CDS out,” Mack said frantically. “Lloyd, you guys are in the same boat as I am.” He then made a request of Blankfein: to appear on CNBC with him, as a show of force.
While Blankfein kept a television in his office, he was so disgusted with what he called Charlie Gasparino’s “rumormongering” that he turned it off in protest. “That’s not my thing,” he told Mack. “I don’t do TV.”
As Goldman wasn’t in total crisis mode, Blankfein explained, he was disinclined to join Mack in a war on the shorts until he absolutely needed to.
Making little progress, Nides had another, perhaps shrewder, angle to play. He could call Andrew Cuomo, the New York State attorney general, who badly needed a cause to resurrect his political fortunes. Nides had a hunch that he might be willing to put a scare into the shorts. It was an easy populist message to get behind: Rich hedge fund managers were betting against teetering banks amid a financial crisis. Everybody remembered what Eliot Spitzer had managed to do to Wall Street from the same platform.